An essential guide to cash flow management
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Posted: Thu 1st Jun 2023
Your small business exists to make you money. But whether you sell goods or services, you need to make a profit. And you can't do that unless you manage your finances and cash flow.
So what are the best ways to do it? Read on to find out.
Money management matters
Cash-flow problems and mismanaged finances are a major reason why many businesses fail in their early years. Some companies don't plan properly, some set their sights too high or low, some don't keep track of costs, some fail to chase payments.
You can give your business the best possible chances of success by being aware of the pitfalls. Then you can manage your company's finances carefully and keep a close eye on its cash flow. Here are some useful tips to consider.
Use financial planning and forecasting
It's useful to develop a financial plan to keep track of finances coming into and going out of your company. For example, one model for your business might be to spend:
50% of revenue on expenses (such as payroll or supplies)
30% of revenue on building the business (such as expanding equipment or recruiting more staff)
20% of revenue on the future, for developing new products and services
But circumstances change. Try to do some simple forecasting of your business for at least the next six months. Be realistic and try to estimate how much you'll sell and how much you'll spend. Plug these numbers into your financial plan and see if the results will still work for your business. If not, you may need to change your plan.
Read more:
How to create a simple cash-flow projection for your business
Create a truly effective financial forecast with these six key tips
Be ambitious but stay realistic
Ambition is an important characteristic of business owners. But so is the ability to make rational financial decisions based on the facts.
When you start a new business, the feeling of control can be exhilarating. Free from the constraints of employment, you can make any financial decision you want to. Some of those decisions will be good. Others won't.
Like any other area of life, learning to run a business comes through experimentation, successes and occasional mistakes. But successful entrepreneurs have two things in common:
They learn from their mistakes
They make small enough mistakes that they can recover from them financially
Taking the occasional risk is part of good business. Taking unnecessarily big risks is not.
Read more:
Get your free Small Business Toolkit
Download your free toolkit for a cash flow forecast template and feel confident about the money moving in and out of your business.
Chart your cash flow
Good accounting software can create charts of inflows (sales of goods or services) and outflows (accounts payable) for your business. If you look at these charts over a period of weeks and months, you'll get an idea of the rates of flow of money into and out of your business.
Obviously, to make a profit, you need the inflows to be greater than the outflows. But the size of the difference is what's important.
It will vary over time because few businesses make a consistent profit day in, day out. Some months or weeks will be good, some not so good. Looking at the charts will help you see the pattern as these values change.
Is the difference between income and expenditure often small? Does it sometimes dip into negative territory? Those are periods when your business is potentially at risk of cash-flow problems. Try to find out what's causing this to happen at specific times. You can then attempt to restructure some aspects of your business to avoid the dips.
Read more:
How to choose the right accounting software for your small business
How to improve your business profits by reviewing your cost base
Make minor adjustments to regulate cash flow
Where possible, you should have enough cash on hand to last you three to six months. That way, if you have a rough month or two, it shouldn't have a major effect on your business.
But if your cash flow is causing problems, don't panic. You may be able to improve the situation without making dramatic changes. For example:
consider negotiating different payment dates with your suppliers to better align inflows with outflows
experiment by reducing your invoicing payment terms by a day or two to encourage customers to pay faster
Manage your company's debt
Debt is a fact of life for many businesses. It might be start-up funding, loans for equipment, or commercial mortgage payments. If the cost of the money you borrow is lower than the return you generate by using that money, it makes sense to borrow.
Assess your debts regularly. Look at what your repayments are costing you, see whether your circumstances have changed, and decide whether you need to reduce, or increase, your debt funding.
And don't forget to shop around. Get your accountant to see if there are better ways for you to borrow.
Review expenses regularly
It's important to keep a close eye on your business's spending. Review all your expenses regularly, preferably with the help of your accountant or financial adviser, who can act as a sounding board.
Remember to keep your personal and professional finances separate: use a separate credit card and bank account for business-related expenses. That makes it much easier to keep track of your company's costs and identify business tax you can write off.
Chase the money you're owed
Understand the importance of collecting money on time so you don't leave cash on the table. Use your accounting software to draw up ageing summaries so you can see who is taking longest to pay.
And then chase them, politely, and keep chasing them until they pay. Make your invoice payment terms and the payment due date very clear, to avoid any confusion.
Read more:
Put financial management at the heart of your business
Managing your finances and cash flow shouldn't be an afterthought. It should be a fundamental part of your business strategy.
To be a successful entrepreneur, you must thoroughly understand the numbers that drive your business. That will give you the knowledge you need to keep your company running, and help it to grow when the time is right.
Looking for finance for your business?
Personalised finance options for start-ups, small businesses, sole traders and freelancers. Take the Funding Hub tool and get recommendations tailored to your financial needs.
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